The Light at the End of the Crisis

Fear and panic have taken over the stock market, the banking system and the economy. It is one of those moments in history when people feel helpless, frustrated and bewildered about what's going on and why it's happening.

Stocks are being pummeled in ways we haven't seen in nearly a century, both here and overseas. The Dow Jones is down nearly 20 percent this week, its second worst week since December 1914. The S&P 500 dropped over 20 percent in what looks to be the worst week in the history of that index (going back to 1928).

Behind all this, the credit system is completely frozen. Banks are now loathe to lend even to each other in the overnight markets that are so vital to the daily financing of American business. And the profits outlook is deteriorating badly, sparking fears that we may have a deep and prolonged recession.

And yet, much good may ultimately come of this terrifying correction.

I commend everyone to read the Wall Street Journal op-ed of Friday written by John Steele Gordon, an eminent financial historian. Gordon writes that there have been financial panics roughly every 20 years throughout American history. He goes all the way back to Alexander Hamilton, who orchestrated the first banking bailout in 1792. From this came a regular money-supply system, a credible U.S. government debt system and something of a disciplined banking system.

Gordon hopes that out of the current crisis we get a better system of well-capitalized banks regulated by a more unified government supervisory apparatus. My view is that the panic will pass and long-run American prosperity will continue. This may seem Pollyannaish right now, but I have great confidence that our free-market economy will come out better, with a strong financial underpinning, when the storm finally ends.

Paradoxical as it may be, strong government actions to stabilize banking are necessary to preserve the free-market-economy system. No free-market economy can survive without stable banking and credit. Without readily available credit, entrepreneurs can't put their new ideas into commercial practice. And without that vital innovation, economic growth suffers.

The trick now is to use government levers in smart and efficient ways. Banks need to be recapitalized without punishing current and future shareholders. Henry Paulson is working on this. More than likely, the Treasury man and the G-7 finance ministers are figuring out a plan that will temporarily guarantee all short-term interbank lending in the New York and London money markets.

Britain has done this for its High Street banks.

But the American and European banks in London are not guaranteed. This is the message of the LIBOR market, which has seized up. As of Friday, the three-month LIBOR dollar rate and its spread against Treasury bills have again increased significantly. This, in turn, is dragging down stocks.

In New York, the market for commercial paper issued by banks also has faltered. In fact, financial commercial paper has dropped nearly $160 billion in recent weeks. That's why the authorities have to step in with a short-term backstop. Other measures to relieve banks of their distressed assets, backstop money-market funds and guarantee all banking deposits will have a positive effect over time, as Paul Volcker noted in the Journal this week.

Meanwhile, the Federal Reserve has essentially moved off its fed funds rate target and is instead focused on injecting huge quantities of new cash into the banking system. The most basic money supply controlled by the Fed is now growing at a 16 percent rate after being nearly flat for 18 months. In the last five weeks, the Fed has injected nearly $700 billion through a variety of lending facilities. This is important. The demand for liquidity during this period of asset and credit deflation cries out for massive new cash supplies from the central bank.

Then there's oil, which is almost forgotten in this panic. The $150 oil shock and elevated prices at the pump are what worsened the credit crunch and hastened the recession. But now oil is about $80 a barrel. When the dust finally clears, lower energy prices will be an important tax-cut, pro-recovery factor. Meanwhile, the exchange value of the U.S. dollar is up 16 percent in recent months. That's an anti-inflationary sign of confidence.

And as Gordon writes, hopefully we have learned to stop forcing banks to give mortgages to uncreditworthy customers and to stop encouraging Fannie and Freddie to package these bad loans.

I recall the despair that surrounded the S&L/junk-bond credit crunch 20 years ago. Nobody believed prosperity would return for a long time. Commentators on the left wrote about the decline of the U.S. economy and American power. Yet the 1990s witnessed a strong prosperity boom — the free-market model of capitalism triumphed, and the socialist model in Russia and elsewhere collapsed.

Yes, the months ahead are going to be tough. But I remain optimistic that our free democracy and free-market economy will survive this crisis, as well.

To find out more about Lawrence Kudlow and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate web page at www.creators.com.

COPYRIGHT 2008 CREATORS SYNDICATE INC.

Comments

The light does not shine for all American's. The dark cloud of bad credit due to forces beyond our control will follow many of us for years. While big money is forgiving all this debt and lousy credit between themselves and soon it will be business as usual, slate wiped clean. But we, the people will bear the weight and the scars of your folly. Every single American who has had to make late payments or default on some of their obligations will have that on their credit report. Tell me, what are you going to do to help them? You can take it to the bank, once you're all on your feet and back on easy street, the credit bureaus and the lenders will punish every American that has missed payments or had to default. Enjoy your black ink and easy credit, rich and wealthy gods of the world in your high, exalted places. Down here, the ink is all red and the skies are cloudy all day.

Sir;.... Do you know what is the most beautiful thing about this whole mess? It is to hear the commentators on the economy and even the president tell people don't worry, be happy, and don't run for the doors, and all the† while they lose more and more value from their stock. Do you wonder what all those who follow the better minds of television into financial ruin are going to do to you people before this is over. I watch it all with amusment, and should not, since my life and my pension are on the line; but I know freedom is often having nothing to lose, and we all might be in that boot before too long. I got nothing to lose, so now I can speak clearly, and honestly... Interest serves no person but the lender. It does not serve the investor buying watered stock, and it does not serve the working man, and it does not serve society. It drives people to distraction and to slavery. And finally we can look around and see what good happens if no one can make a profit, or make an interest off the deal. Can the people who produce all goods not live without interest feeding off their efforts? Can government really not get by with taxing wealth? Can nothing good be done without feeding a loan shark some where down the line? The good of the whole society has been turned into so many promises of jam tomorrow. We need our jam today; but that factory has been shipped over seas for a higher profit paying higher interest. The productive capacity of this land has been robbed, for interest and profits. Fair wages have been denied for interests and profits. Credit was made a substitue for fair wages, and because it denied saving, personal capital had to give way to a hand to mouth existence. I have asked this question before, and I ask it now: WHERE is the economy in your economy. You guys count every bean. You don't understand that people have always survived on what the hogs wouldn't eat, on the waste, on left overs; but they cannot live on nothing. I want you to know something. Wall Street set the price of cotten in slave days. They squeezed ever penny of profit out of man's inhumanity to man. They set the price of cotton at what it took to replace the human being whose labor produced it after that person was worked to death. What they once did for the slaves they have done for this whole nation. They have reduced our efforts and our lives to nothing. Watch them zero out the balance books and start out with capital where they left off, squeezing and bleeding profit out of this people and all of humanity. A dollar sign has no soul, but it can rob the souls out of all of humanity....if we let it... Thanks...Sweeney

Mr. Kudlow, didn't you refer to our free market economy? The emphasis should be on the free part. Why would you want the entity that caused the mess in the first place--government--to be the one to "fix" the mess. You say you read the Wall Street Journal. I guess you didn't see Dan Henniger's brilliant commentary on our massive, bloated government being on the verge of imploding.

There are those who say that the run on the markets is overarching fear of an Obama presidency. People are parking their money elsewhere until the election is over. Foreign markets are emulating ours because that's what they do.

Re: jean; Ma'am;...There is a big difference between being free and being an insane lunatic on the loose. If the economy is so strong, we can throw a loop over it, and tie it to a treadmill. Instead, we are all deep in debt, and the government is bottomed out trying to keep that idiot out of trouble. Isn't it like a wild river† that we can use, and protect ourselves from? Must we always be used by it without recourse? Our economy has sold us cheap. We deserve better from life than our economy has afforded us. Under the circumstances it is a crime that people are governed, and business is not. The economy is a wild river. If we do not learn to tame it, it will wash us away. Thanks...Sweeney